Tuesday, 16 September 2014

A
series of revisions to production targets will result in lower oil output from Iraq than
originally planned.

On 4 September, Iraq reached
an agreement with BP and the Chinese oil company CNPC to lower the planned
production target for Rumaila, the country’s largest oil field. The agreement
is not a one-off—it is part of a series of revisions to the targets that had
been originally agreed on with international oil companies in 2009. The
revisions will lead to a sharp fall in Iraqi oil output relative to the
original unrealistic plans.

The BP/CNPC deal
does not come as a surprise. For months international oil companies have been
negotiating lower production targets for the fields they run. ExxonMobil agreed
with the Iraqi government on a lower production target for the West Qurna-1
field. Lukoil did the same for West Qurna-2. Likewise for Eni and CNPC, the
operators of Zubair and Halfaya, respectively. Only Shell is yet to agree with
the Iraqi government on a new output target for the Majnoon field. It is
lobbying for a reduction from 1.8 million barrels per day (mb/d) to only 1.o mb/d, but
the Iraqi government is holding out for 1.2 mb/d. (The table below provides a
summary of the original and revised production targets by field.)

Such broad
revisions to the original agreements indicate a flaw in the way the contracts
had been awarded. The process involved oil companies submitting bids
specifying: (1) production target (the peak level of output the company would
eventually produce from the field); and (2) remuneration for developing the
field and reaching the target. Iraq then chose the bids with the highest production targets (since they result in more revenue) and lowest fees (less cost). But as
pointed out by James Hamilton, these auctions
encouraged oil companies to exaggerate production targets in order to win the
contracts. Once awarded, they began negotiating lower targets to move from “propaganda
to the reality”.

What does the new
reality hold for Iraq? The path of future Iraqi oil production will be
significantly lower than originally planned. Instead of producing 11.0 mb/d
from the six fields listed in the table above by 2020, Iraq has to settle for
only 7.2 mb/d. And even this target looks overly optimistic. To achieve it,
Iraq has to be more stable and efficient in the next six years than it has been
in the last five.

The production
loss is even bigger if we include the fields of Qayara and Nejma, which were
projected to add 230 kb/d by 2020. Sonangol, the Angolan company which had won
the contract to develop them, pulled
out of the country in February due to deteriorating security situation. The fields
are now under the control
of the Islamic State of Iraq and al-Sham, and there is
little hope for production growth from either of them.

Finally, while
BP/CNPC were not alone in negotiating a revised production target, the agreement
unusually included raising their shares in Rumaila. BP’s share increased to 47.6%
and CNPC’s to 46.4%, while Iraq’s stake was reduced to 6%. Iraq had previously maintained
a 25% share in all oil fields, and it is not clear whether this reduction is
unique to the BP/CNPC agreement or if it also applies to the other revised
deals. Iraq might be moving from propaganda closer to reality, but transparency
is still in short supply.

Monday, 1 September 2014

The
conflict in Iraq is unlikely to materially reduce oil production but could lead
to a significant slowdown in its growth.

The International
Energy Agency has released the full text of its monthly Oil Market Report. The report
raises interesting points about the current state of Iraqi oil production, some
of which I discuss below.

Source: International Energy Agency

1. Iraqi oil production continues
unabated, despite the ongoing violence. Officially, Iraq's daily oil production
averaged 3.1 million barrels per day (mb/d) in July. Oil fields in Kirkuk
pumped 0.16 mb/d; the Kurdish Regional Government (KRG) produced 0.31 mb/d;
with the southern fields responsible for the remainder of production at around
2.65 mb/d.

2. By capturing Kirkuk,
the KRG has doubled the production capacity under its control to around 0.85
mb/d. However, logistical constraints and political/legal disputes with the
central government in Baghdad has kept production at half capacity.

3. Logistically, the KRG does not have
the infrastructure to refine or export additional oil production. Fighting
around Baiji has resulted in the closure of Iraq’s biggest refinery—with 0.3
mb/d capacity. Furthermore, the Kurdish private pipeline, which has been used
to transport independent Kurdish exports, can accommodate current Kurdish
exports but very little on top of that.

4. The dispute with Baghdad over
independent oil exports has made it difficult for the KRG to find international
buyers. Of the six KRG cargoes which have left the Turkish port of Ceyhan since
May, only one has managed to offload its contents—at the Israeli port of Ashkelon.
Another cargo is a subject of a legal dispute before a US
court between Baghdad and the Kurds.The rest are still in limbo.

5. The Islamic State of Iraq and
al-Sham (ISIS) has added Ain Zahla and Batma to its existing
portfolio of oil fields, which consists of Najma, Qayara, Himreen, Ajeel and
Balad. This means that ISIS controls 80 thousand barrels of daily oil
production in Iraq alone—equivalent to 2.6% of the total official Iraqi output
(including the KRG).

6. Oil production and smuggling has been reportedly providing
ISIS with $2 million a day. These reports are not backed by hard data but
they seem plausible if we assume that ISIS is producing at 50% of capacity (40
kb/d) and selling crude at half price ($50 per barrel). It also means that losing
the oil fields could deal a significant blow to ISIS by depriving it from a
valuable source of funding.

7. Southern oil accounts for 85% of Iraqi
production and all official exports. Southern production and export
facilities are quite distant from the conflict zones in the north and west of
the country, and have been immune from sabotage. In the short term, violence is
likely to have limited impact on Iraq’s ability to pump and export oil.

8. In the medium term, violence could have quite a negative impact on oil
production and exports. First, the general deterioration in the country’s security
situation could lead to a disruption in foreign investment and missing out on
ambitious production targets. Some companies, such as BP and ExxonMobil, have
already withdrawn
non-essential staff. Second, trade partnerships are likely to be
tested, with China and India—the largest importers of Iraqi oil—pre-emptively looking
for supply alternatives.

Search This Blog

Follow by Email

About Me (Ziad Daoud)

I am an economist currently based in the Middle East. I have previously worked for an asset management firm and, before that, I did a PhD at the London School of Economics. The views in this blog are solely my own.